Managerial Finance Ch 28
Identify the real-world captive finance companies.
FMC GMAC
What does it imply if the buyer is presented with a draft and the buyer "accepts" it?
The buyer promises to pay it in the future.
What is the buyer's receivables period?
The time it takes the buyer to collect on the sale
Which of the following is true about bank acceptances?
They are actively traded in the money market. They are commonly used in international trade. A bank guarantees payment.
In practice, firms that grant credit often contract the credit function to:
a factor a captive finance company an insurance company
What type of account is created when a firm issues credit?
accounts receivable
The time period that it takes to collect on a credit sale is known as the _____.
accounts receivable period
The required return on receivables is a _____.
carrying cost of granting credit
A delay in payment can occur when a company extends _____.
credit
When a cash discount is offered, the credit is free ______ period.
during the discount
If a firm decides to grant credit to its customers, then it must _____.
establish procedures for extending credit and collecting
Low demand products may have a _____ credit period to try to increase sales.
longer
Credit analysis is important simply because _____.
of the potential losses on receivables
In order to entice buyers to pay early, a firm may _____.
offer a cash discount
With EOM dating, the seller bills ______ a month.
once
What fraction of all the assets of U.S. industrial firms are in the form of accounts receivable?
one-sixth
What is the length of time for which credit is granted called?
the credit period
The best predictor of whether or not someone will pay in the future is _____.
whether or not they've paid in the past
If the variable cost is $30 per unit, the price is $50, the probability of default is 16 percent, and the discount rate on receivables is 5 percent, then the NPV of granting credit to a one-time customer is _____.
$10 NPV = −$30 + (1 − 0.16) × $50/(1.05) = $10.
If the benefit of changing credit policies is expected to be $100 per month forever, and if the monthly required return is 1 percent, the present value equals _____.
$10,000 $100/0.01 = $10,000.
If granting credit results in an increase of sales of 20 items per month while the gross profit per unit remains constant at $30, then the present value of this perpetual change at a required return of 0.5 percent per month forever is _____.
$120,000 PV = (20 × $30)/0.005 =$120,000.
Suppose Veeco charges $150 per unit, its variable costs are $100 per unit, and it sells 1,000 units per month. The company is considering extending credit to its customers, allowing them 30 days to pay. Doing this is expected to increase sales to 120 units per month. What is the NPV of this proposal if its required rate of return is 3 percent?
$16,333 PV Benefit: [(120 − 100) × (150 − 100)]/0.03 = $33,333. PV Cost: [(120 − 100) × 100] + (150 × 100) = $17,000.
If the variable cost is $6, the probability of default is 50 percent, the price is $12, and the rate of return is 10 percent, the NPV of extending credit to a new customer who has the potential to be a repeat customer is _____.
$24 NPV = -$6 + (1 - 0.5)($12 - $6)/0.10 = $24.
If the variable cost is $20 per unit, the price is $40, the probability of default is 30 percent, and the discount rate on receivables is 3 percent, then the NPV of granting credit to a one-time customer is _____.
$7.18 NPV = −$20 + (1 − 0.3) × $40/(1.03) = $7.18.
If the credit terms are 1/10, net 30, then the buyer can pay $1,000 in 30 days or ______ in 10 days.
$990
If the cost of changing a credit policy is $5,000, and if the PV of the benefit is $4,500, then the NPV is _____.
-$500
If a company switches from all cash to net 30 sales, but there is no increase in sales (P × Q), then the NPV equals _____.
-PQ
If the credit terms are 1/10, net 30, then the buyer can pay full price in 30 days or take a ______ discount and pay in 10 days.
1 percent
The typical sequence of events that occur when a firm grants credit is _____.
1. the credit sale is made 2. the customer sends a check to the firm 3. the firm deposits the check 4. the firm's account is credited
About _____ of all assets of U.S. industrial firms are in the form of accounts receivable.
1/6
With 2/15, net 40 terms, a rational buyer either pays in ___ days or in ___ days. If he gives up the discount, he gets ___ days of free credit.
15; 40; 25
If the variable cost is $30, the price is $40, and the required return is 5 percent, then the break-even probability of default for a one-time customer is _____.
21 percent π = 1 - $30/$40 × 1.05 = 21%.
Suppose a firm currently offers terms of net 40 and has an average collection period (ACP) of 40 days. If it offers terms of 1/10, net 40, and if 40 percent of the customers pay in 10 days and 60 percent pay in 40 days, then the new ACP will be ______ days.
28 ACP = 0.60 × 40 + 0.40 × 10 = 28 days.
If the terms of sales are 3/15, net 60, what is the discount available?
3 percent if paid within 15 days
What is the break-even sales increase a company needs if its current sales level is $5,400, its price and variable cost per unit are $30 and $20, respectively, and the discount rate is 5 percent per period?
30 units $5,400/(10/0.05 - 20) = 30 units.
If the variable cost is $20, the price is $50, and the required return is 25 percent, then the break-even probability of default for a one-time customer is _____.
50 percent π = 1 - $20/$50 × 1.25 = 50%.
What is the effective annual cost of forgoing a discount if terms are 2/15, net 30?
63.49 percent (1.020408)365/15 − 1 = 0.6349, or 63.49%.
Which of the following are true?
Credit insurance offers coverage up to a preset dollar limit. Firms with internal credit operations are self-insured against default.
Which of the following are the most popular business credit reporting agencies?
Experian Dun & Bradstreet
True or false: The standard credit period is normally between 6 to 12 months.
False
True or false: Credit analysis refers to the process of deciding whether or not to extend credit to customers in general. True false question.
False It refers to a particular customer, not customers in general.
True or false: A seller cannot offer different terms to different buyers.
False The terms can vary. For example, a wholesaler is likely to get better terms than a retailer.
True or false: There is no downside to extending trade credit.
False There are two costs to extending trade credit: 1) there is a chance the customer will not pay, and 2) the firm has to bear the costs of carrying the receivables.
Some examples of real-world captive finance companies are _____.
Ford Motor Credit GMAC
What is the another term for a promissory note?
IOU
What is the danger of extending credit?
It may lead to delays in payment.
Which of the following statements are true about extending credit?
Repeat business is a crucial consideration. Extending credit to everyone is not a bad strategy.
What trade-offs are made when trade credit is issued?
Sales may increase but the cost of carrying receivables will also increase. Sales may increase but the probability of defaults will also increase.
____ dating might be used to encourage sales of products during off-season.
Seasonal
True or false: Banker's acceptances are common in international trade.
True
True or false: In analyzing repeat customers, it is often assumed that a customer who does not default the first time will never default.
True
True or false: Sellers frequently quote different credit terms to wholesale and retail customers.
True
True or false: A credit instrument is the basic evidence of indebtedness.
True It is signed and recorded by both parties.
Whether the firm sells for cash or credit, it will still have to _____.
acquire or produce the merchandise and pay for it
The main problem with promissory notes is that they are signed _____.
after the delivery of goods
Where do credit sales appear in the balance sheet?
as accounts receivable under current assets
The credit period generally increases _____.
as the size of an account increases
When a draft is signed and stamped by the bank it is called a _____ _____.
bankers acceptance
A commercial draft is a way to obtain a credit commitment from a customer ______ the goods are delivered.
before
The invoice date represents the _____.
beginning of the credit period
Two major factors that affect the length of the credit period are the _____.
buyer's inventory period operating cycle
The amount of time it takes the buyer to collect on a sale is known as the _____.
buyer's receivables period
The time it takes the buyer to acquire inventory, process it, and sell it is known as the _____.
buyers inventory period
How can the receivables period be reduced?
by reducing processing float by speeding up check mailing
A(n) ______ finance company is a wholly owned subsidiary that handles the credit function for the parent company.
captive
Extending more than the cost-minimizing amount of credit will not cover the ______ costs of the investment in receivables.
carrying
Total credit cost is minimized when _____.
carrying costs equal opportunity costs
Which of the following refers to an asset pledged in the case of default?
collateral
The three components of credit policy are _____.
collection policy credit analysis terms of the sale.
What are the main components of a credit policy?
collection policy terms of sale credit analysis
With a conditional sales contract, the selling firm will retain legal ownership of the goods until the customer _____.
completes the payment
Which of the following factors are used in evaluating credit policy?
cost effects revenue effects the cost of debt
Some problems with issuing credit are _____.
cost of carrying receivables the risk of the customer not paying
For which of the following types of sales would the firm be most likely to suffer nonpayment?
credit
The procedures businesses go through to determine if a customer is likely to pay is called _____.
credit analysis
What is the process of deciding whether or not to extend credit to a particular customer called?
credit analysis
The factor may have full responsibility for which of the following?
credit checking authorization
The sum of the carrying costs and the opportunity costs of a particular credit policy is called the _____.
credit cost curve
The terms of sale specify the:
credit period discount period cash discount type of credit instrument
Issuing credit is an investment in the _____.
customer
The optimal amount of credit is determined when the incremental cash flows from increased sales are _______ the incremental costs of carrying the increase in investment in accounts receivable.
exactly equal to
All things equal, which firm characteristic will NOT usually lead to a firm granting more credit?
fewer repeat customers
The cost of debt matters in evaluating credit policy because the resulting receivables must be ______.
financed
Which of the following are sources of information for assessing creditworthiness?
financial statements banks
Firms can sometimes achieve a lower overall cost of debt by _____.
forming a separate company to handle the credit function
Which of the following are steps in the credit-granting process?
gathering relevant information determining creditworthiness
The role of the cash discount in credit policy is to _____.
get customers to pay early
Because of cash discounts, businesses that extend credit are able to charge ______ prices to customers that use credit.
higher
Conditional sales contracts are usually paid _____.
in installments
A firm that grants credit may experience an increase in revenue due to an increase in price and a(n) ______ in quantity sold.
increase
Issuing credit to customers should _____.
increase sales
The major reason for issuing credit is to _____.
increase sales
The optimal amount of credit is determined when the ______ cash flows from increased sales are exactly equal to the incremental costs of carrying the increase in investment in accounts receivable.
incremental
Granting credit results in delayed revenues, but the costs of sales is _____.
incurred immediately
The two components of the operating cycle are called the ______ period and the ______ period.
inventory; receivables
A(n) _____ is a written account of merchandise shipped to the buyer.
invoice
Because most trade credit is offered on open account, the most used credit instrument is the _____.
invoice
Issuing credit creates a trade-off between increased sales and the cost of _____.
issuing credit
Sellers may offer even ______ credit periods for off-season sales.
longer
With higher levels of competition, a _____ credit period is a good way of attracting customers.
longer
Which of the following are opportunity costs of refusing to grant credit?
losing the ability to charge a higher price a decrease in quantity sold
Perishable items usually have a relatively _____ collateral value.
low
All things equal, which firm characteristics will usually lead to a firm granting more credit?
low variable operating costs the presence of excess capacity
Which of the following are part of collection policy procedures?
monitoring receivables collecting on past-due amounts
The appropriate upper limit to the credit period is the length of the buyer's ______.
operating cycle
When the seller's credit period exceeds the buyer's inventory period, then the seller is financing _____.
part of the buyer's receivables the buyer's inventory purchases
In granting credit, a firm must assume some _____.
probability of nonpayment
A(n) _____ note is essentially an IOU that a customer will sign when an order is large.
promissory
Issuing credit to customers will:
promote sales make an investment in a customer
Cash discounts encourage early payment which reduces the firm's investment in _____.
receivables
If our credit period exceeds the buyer's inventory period, then we are financing not only the buyer's inventory purchases but also part of the buyer's ______.
receivables
The focus of credit analysis is on losses incurred on _____.
receivables
If a firm grants credit, then there will be a delay in _____.
revenue collections
Which of the five basic factors in evaluating credit policy is impacted by possible price and quantity effects?
revenue effects
Firms that manage internal credit operations are _______ against default.
self-insured
The decision to forgo a trade discount almost surely works to the __________ advantage.
sellers
Factoring is an arrangement where a firm ______ its receivables.
sells
The primary reason to set up a credit function subsidiary is to ______ the production and financing of the firm's products for management, financing, and reporting.
separate
The cost of ______ borrowing is a factor in the decision to grant credit.
short-term
A higher credit risk buyer will usually receive a _____ credit period.
shorter
A lower priced item will tend to have a _____ credit period.
shorter
If there is very little competition, the credit period offered is likely to be _____.
shorter
Perishable items usually have a ____ credit period.
shorter
Relatively standardized goods and raw materials tend to have ______ credit periods.
shorter
The smaller the account, the ______ the credit period.
shorter
There are two buyers, Sam and Bradley. Sam has a higher credit risk than Bradley. We can conclude that the credit period for Sam will be relatively _____.
shorter than Bradley's credit period
Immediate payment is required on a _____ draft.
sight
Which of the following are not ways to reduce the receivables period?
slow down check processing slow down check clearing
A company will offer a discount in order to _____.
speed up the collection of receivables
With terms of 2/10, net 30, and an order of $1,000, the cost of not taking the discount is computed assuming that _____.
the buyer borrows for 20 days the buyer pays $20 in interest on the "loan" the buyer borrows $980
The credit period will be shorter when _____.
the buyer's inventory period is shorter the buyer's operating cycle is shorter
What are the two components of the credit period when a cash discount is offered?
the cash discount period the net credit period
What does a credit score show?
the creditworthiness of a customer
The change in quantity sold under a new credit policy is _____.
the extra potential profit from credit sales that are lost because credit is refused
If the level of receivables is below the minimum total credit costs, then _____.
the firm is forgoing valuable profit opportunities
What provides a written documentation of merchandise shipped to a buyer?
the invoice
What is the beginning of the credit period called?
the invoice date
Which of the following are forms of carrying costs when granting credit?
the losses from bad debts the required return on receivables
If a firm decides not to extend credit to a returning customer, it will collect _____.
the price
The net credit period is _____.
the time by which the customer has to pay
The credit period refers to _____.
the time for which credit is granted
What is the inventory period?
the time from acquisition of inventory to sale of inventory
The term 2/10, net 60 means _____.
there is a 2 percent discount if the invoice is paid off in 10 days, otherwise the entire amount is due in 60 days
If immediate payment is not required on a draft, then it is a ______ draft.
time
The cash discount period is the _____.
time during which the discount is available
Why do firms perform credit analysis?
to determine the creditworthiness of customers
If credit is extended to a returning customer, the ______ sales price is risked.
total
Cash discounts allow businesses to charge higher prices to customers that _____.
use the credit extended to them
